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AUTHOR:  aBIZinaBOX Inc. CPAs – Jordan S. Zoot, CPA
PUBLISHER:  CANNABIS LAW REPORT

Un Pesce Marcisce Dalla sua Testa is an old Sicilian proverb that translates “a fish rots from its head”. The statement appears to be an accurate summary of present condition of both the private and governmental sides of California’s cannabis industry.

A Los Angeles Times article September 11th that was headlined “Nearly” stated,

‘The audit[1], conducted by the United Cannabis Business Association.[2], found approximately 2,835 unlicensed dispensaries and delivery services operating in California. By comparison, only 873 cannabis sellers in the state are licensed, according to the Bureau of Cannabis Control [“BCC”]

 

We were a bit surprised to discover that UCBA is afflicted by the same type of intentional disregard for the statutes and regulations governing not-for-profit corporations, business leagues and mutual benefit corporations as other California cannabis businesses. Most of the organizations that purport to speak for the businesses and individuals that comprise California’s legal cannabis industry are under suspension, never completed registrations, filed erroneous organizational documentation, or have failed to file correct tax returns and reports with the California Department of Tax and Fee Administration (“CDTFA”) or the California Attorney General Charities Division [See Who is Inept? ].

 

The September 11th article continues,

 

This year, an industry-backed financial audit projected that roughly $8.7 billion will be spent on unregulated cannabis products in California in 2019, compared with just $3.1 billion spent on cannabis sold by legal businesses.”

 

If we accept those figures, then the average “black market” cannabis business has annual sales of $3.1MM, and the average “legal dispensary” has sales of $3.6MM. We have created numerous models of the financial revenues, costs and returns for the legal cannabis industry in California [See Allocation – Costs – Gross Profit – Taxes and It’s the Math]. The taxes that California should be collecting are approximately 31% of the gross receipts of cannabis businesses, or $960K for each “black market” cannabis entity, and $1.1MM per legal cannabis entity. The annual total for cannabis taxes for “black market” and legal business should be $3.66B [2,835 *$960K + 857*$1,100K] for the current year.

 

It is our recollection CDTFA recently announced the cannabis taxes collected for the second quarter of 2019 were $144.2MM[3] vs. $915MM California should be collecting. While we understand there are several contributing factors, we will start by laying blame on CDTFA. CDTFA has proved to be inept, inefficient and lethargic in its administration of cannabis taxes. It also was incredibly poor in its design of its systems and controls for the collection, reporting and remittance of cannabis taxes [See Missing or Uncollected and Taxes – Cannabis – Myth  and Cannabis Taxation – Reality Check].

 

We have commented extensively on the underlying problems. We have described proposed corrective actions CDTFA and the regulatory agencies could take. With rampant abuse of the law by industry associations and experts combining with a perpetuation of “black market” businesses, and death and maiming from toxic vaping cartridges[4], it seems unlikely the California Attorney General, the United States Attorneys for the Districts in California, the Drug Enforcement Administration [“DEA”] will continue for long to treat the stand down from the “War on Drugs”[5] as meaning to become catatonic.

 

There is a place for aggressive law enforcement efforts in California’s cannabis industry [e.g. flagrant tax evasion, circumvention of laws that places the health and safety of the public at risk, and repeat offenders engaging in significant illegal cannabis activity] are warranted. At some point, such individuals need to have the “entire bookcase” thrown at them.

 

While we understand the urgency of preventing further loss of life with toxic vaping cartridges, we view the abuses by the organizations we identified in “Who is Inept?” to be equally toxic to the legal cannabis industry. Those who knowingly violate the laws and regulations relating to nonprofit and tax exempt status should also aggressively prosecuted.

 

On the public side it is also galling to us when we see local governmental agencies selling licenses to cannabis businesses that will never succeed in order to generate license application revenue and encouraging cannabis businesses based on “social equity” without providing the support and training required for such businesses to succeed. A number of local jurisdictions are as culpable as the abusers of the tax and nonprofit laws with their encouragement of cannabis business investment in the local community for the supposed tax revenue that will be generated.

 

Greed drives the public side at a local level as hard as it drives the private side.

 

[1] We note that the term “audit” is being used as a journalist rather than as it would be by the only professionals licensed to perform “audits” or examinations of financial statements – certified public accountants [“CPA’s]. The definition of an audit or examination of financial statements is described California Business and Professions Code, Division 3, Chapter 1, Article 3, Section 5051(c).

[2] United Cannabis Business Association [“UCBA”] is a DBA of a California Nonprofit Mutual Benefit Corporation organized under the name UCBA Trade Association.   The California Secretary of State Corporate No. is: C3857701; the California Attorney General Registry No. is: CT0229633. The Articles of Incorporation state is an IRC Sec. 501(c)(6) organization.

 

IRC Sec. 501(c)(6) of the Internal Revenue Code provides for an exemption from income tax for business leagues, chambers of commerce, real estate boards, boards of trade and professional football leagues, which are not organized for profit and no part of the net earnings of which inures to the benefit of any private shareholder or individual. An organization that otherwise qualifies for exemption under IRC Sec. 501(c)(6) will not be disqualified from the exempt status merely because it engages in some political activity. In addition, the organization may engage in lobbying that is germane to accomplishing its exempt purpose without jeopardizing its exempt status.

 

A business league is an association of persons having some common business interest the purpose of which is to promote such common interest and not to engage in a regular business of a kind ordinarily carried on for profit. Trade associations and professional associations are business leagues. In order to be exempt from income tax, a business league’s activities must be devoted to improving business conditions of one or more lines of business as distinguished from performing services for individual persons.

 

No part of a business league’s net earnings may inure to the benefit of any private shareholder or individual and it may not be organized for profit to engage in an activity ordinarily carried on for profit (even if the business is operated on a cooperative basis or produces only enough income to be self-sustaining).  The term line of business generally refers either to an entire industry or to all components of an industry within a geographic area.  It does not include a group composed of businesses that market a brand within an industry.

 

[3] See California Department of Tax and Fee Administration Reports Cannabis Tax Revenues for the Second Quarter of 2019

[4] Deaths, illnesses related to vaping cannabis on the rise, health authorities say

[5] Bringing Back The War